China Shadow Bankers Go Online as Peer-to-Peer Sites Boom


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An eternal optimist, Liu-Yue built two social enterprises to help make the world a better place. Liu-Yue co-founded Oxstones Investment Club a searchable content platform and business tools for knowledge sharing and financial education. also provides investors with direct access to U.S. commercial real estate opportunities and other alternative investments. In addition, Liu-Yue also co-founded Cute Brands a cause-oriented character brand management and brand licensing company that creates social awareness on global issues and societal challenges through character creations. Prior to his entrepreneurial endeavors, Liu-Yue worked as an Executive Associate at M&T Bank in the Structured Real Estate Finance Group where he worked with senior management on multiple bank-wide risk management projects. He also had a dual role as a commercial banker advising UHNWIs and family offices on investments, credit, and banking needs while focused on residential CRE, infrastructure development, and affordable housing projects. Prior to M&T, he held a number of positions in Latin American equities and bonds investment groups at SBC Warburg Dillon Read (Swiss Bank), OFFITBANK (the wealth management division of Wachovia Bank), and in small cap equities at Steinberg Priest Capital Management (family office). Liu-Yue has an MBA specializing in investment management and strategy from Georgetown University and a Bachelor of Science in Finance and Marketing from Stern School of Business at NYU. He also completed graduate studies in international management at the University of Oxford, Trinity College.

By Luo Jun. Editors: Sheridan Prasso, Robert Friedman, From Bloomberg News,

Jack Qiu, spending evenings in front of his laptop in the southern Chinese city of Guangzhou, is earning the best returns of his life: 14.2 percent on an annualized basis in just two months.

He’s doing it by lending money to strangers online. An accountant by day, Qiu has turned out to be a better loan manager by night than most banks. Only two investments out of his 80,000 yuan ($12,525) total, each worth 100 yuan, have gone unpaid. Nonperforming loans at a Chinese lender, on average, would be almost four times as much.

“I don’t care what the money is used for because that’s beyond my control,” said the 30-year-old certified financial planner who jumped into online lending in May by registering at, one of China’s largest such sites. “For me, the key is to identify those who have at least a willingness to honor their debt, so I need to keep my eyes wide open.”

Peer-to-peer lending is taking off in China as traditional methods of private lending among family and acquaintances, part of the country’s unregulated $2.4 trillion shadow-banking system, move online. More than 2,000 websites have been set up nationwide since 2007, China National Radio reported in May. Loans brokered online increased 300-fold to 6 billion yuan in the first half of 2011, the latest figures available, from the full year total in 2007, the report said.

’Innovative Lending’

Akin to or in the U.S., China’s peer-to-peer lenders let individuals invest a minimum of 50 yuan in projects ranging from small-business expansion to funding newlyweds’ honeymoons for as much as 23 percent interest, the highest rate allowed under Chinese law. While the returns are higher than parking the money in bank accounts earning 3 percent, they’re dwarfed by some underground shadow-banking investment yields that can go as high as 100 percent.

“This is an interesting and innovative lending platform with a lot of goodwill,” said Liao Qiang, a Beijing-based director for financial institutions at Standard & Poor’s.

Existing outside of regulators’ jurisdiction, online lending sites aren’t without risks. The China Banking Regulatory Commission in September issued a warning about web-based brokers, cautioning that their bad-loan ratio is “significantly higher” than that of banks — without specifying the figure — and that they can cross the line into illegality such as fraud, funding illegitimate businesses or money laundering.

A Beijing-based spokesman for the banking regulator said peer-to-peer lending isn’t under its official purview.

“There is no discipline at all,” Liao said, calling it a “short-lived fad” that won’t affect the role banks play in the economy. “There’s no enforcement should borrowers default.”

Prosper Marketplace

Online peer-to-peer lending started in the U.K. in 2005 and spread to the U.S., Germany and elsewhere. Prosper Marketplace Inc., the first such U.S. lender, reported a 179 percent increase in volume in 2011 and has almost 1.4 million members funding $369 million in loans.

Lending online became popular in China after a tightening of bank credit in 2010 following two years of stimulus spending to fight the global financial crisis. With total loan volume less than $1 billion, it’s still a tiny part of the country’s shadow-banking universe — along with underground lending, off- balance-sheet financing by banks and investments by trust firms — that policy makers led by Premier Wen Jiabao are trying to bring under government oversight.

The total amount that circulates as loans among friends, families and companies is $1.3 trillion, according to estimates by research firm IHS Global Insight Ltd. (IHS), an amount equal to last year’s U.S. budget deficit.

Microfinance Inspiration

The Ppdai site, which calls itself China’s first and largest, was founded by former Microsoft Corp. engineer Zhang Jun and three former classmates from Shanghai Jiaotong University. Zhang said they found inspiration when Bangladeshi economist Muhammad Yunus and his Grameen Bank won the Nobel Peace Prize in 2006 for lifting millions out of poverty by making small loans through what is known as microfinancing.

Reeling from a failed YouTube-like website, the friends decided to pool their remaining savings of 200,000 yuan to connect borrowers with investors via the Web. The catch: None of the founders, including one who was a corporate lawyer at the time, knew if it was legal.

“We went ahead because we couldn’t find any regulation that specifically bans it,” Zhang, 35, said in an interview at his Shanghai Ppdai Financial Information Services Co. office in a shared space for startup companies at a high-tech park in Shanghai’s Pudong district. “We knew the demand was there. So was the supply.”

Loan Requests

Like San Francisco-based Prosper, Ppdai requires borrowers to list basic personal information and details of their financing needs. Investors review the requests and make investments that meet their criteria. About 80 percent of the total 400 million yuan of lending brokered by Ppdai since 2007 has gone to small businesses, Zhang said.

Only 3 percent of China’s 42 million small and medium-sized firms are able to get loans from banks, according to an estimate by Citic Securities Co., while 36.7 trillion yuan of household savings are parked in banks. Half of that amount earns as little as 0.35 percent a year in checking accounts, with the remainder earning a 3 percent savings rate, which the government lowered from 3.5 percent in June.

A recent loan request by an online sportswear retailer in Hunan province asked for 11,970 yuan to buy inventory for the fall season, paying 20 percent interest. Another borrower in Shandong province is seeking 50,000 yuan to purchase manufacturing equipment, paying 18 percent.

Default Risk

Ppdai, which in Chinese is short for “lending through auctions,” claims more than 1.1 million registered users. Loan amounts start at 3,000 yuan and are capped at 500,000 yuan, with lenders contributing a minimum of 50 yuan. The maximum interest rate by law, 23 percent, can’t exceed four times the benchmark lending rate, now 6 percent for one-year loans. Credit cards usually charge 18 percent.

“It’s fairly easy to get consumer loans and credit cards from banks nowadays,” S&P’s Liao said. “If someone is unqualified for that, he may very likely end up being a borrower online and the default risk is extremely high.”

About 3.5 percent of Ppdai’s loans aren’t paid off on time, Zhang said, while 1.2 percent have been overdue for at least 90 days, the definition of nonperforming at Chinese banks. That compares with the 0.9 percent bad-loan ratio of the nation’s commercial banks as of the end of March, according to data from the banking regulator. The rate by investor Qiu of 0.25 percent is considerably lower than Ppdai’s average.

Online Rescue

The default rate of LendingClub Corp., a U.S. peer-to-peer lending site which issues consumer loans of as much as $35,000 for everything from home repair to exotic vacations, has been below 3 percent since its inception in 2007, while at Prosper the loan-loss rate is about 5 percent, according to the companies’ websites.

One Chinese borrower, 29-year-old Xu Xiaolong, counts herself a beneficiary after a lending website helped her family survive a difficult period in May. Xu’s husband had a car accident and needed 30,000 yuan to pay his medical bills.

Days before the accident, the couple had put 1 million yuan, their entire savings plus some loans from relatives and friends, into a nonrefundable investment. They bought 30-year rights to eight acres of green-tea fields in Fujian province.

Hongling Chuangtou Ecommerce Co., which operates the lending website from Shenzhen, increased Xu’s borrowing limit after learning what happened. She was able to raise all the money she requested in one day at an 18 percent annual rate.

‘Great Platform’

“It’s a great platform to resort to if you have urgent needs,” Xu, who had been a borrower and lender previously, said in a telephone interview. “I am truly thankful for it.”

Ppdai, which charges borrowers a fee of as much as 4 percent of their loans, began to break even early last year, Zhang said. Almost 80 percent of the company’s monthly revenue of 500,000 yuan goes to the salaries of its 40 employees, while the rest is reinvested in the business, he said.

China’s lack of a credit-scoring system makes risk management difficult for peer-to-peer lending, giving potential lenders no way to gauge borrowers’ creditworthiness.

For most online platforms in China, risk-control measures include checking whether the personal identification or business license of the borrower has been photo-shopped. Those who have defaulted have their names and contact numbers disclosed on the front page of the website.

“Coming from a technology background, it took us a while to realize that risk management is key to the business,” Zhang said. “But we can do just enough to reduce default and prevent fraud, so we urge investors again and again not to put all their eggs in one basket.”

‘Ponzi Scheme’

Some peer-to-peer sites have shut down., a Shanghai-based online loan broker with almost 100,000 registered users, closed in July 2011, about 18 months after it started, because the company didn’t have enough capital, the Economic Observer reported., which went live on June 3, became inaccessible five days later, with more than 1 million yuan in investments from at least 80 users missing, the China Business News reported last month, calling it the first “Ponzi scheme” in the country’s peer-to-peer lending business.

“Unlike banks, these middlemen are unable to collect information on borrowers and manage loans afterwards,” the regulator warned in September. “In the event that illegal activities such as malicious fraud or even money laundering occur, it will endanger the entire society.”

Suicides, Bankruptcies

The same concerns have haunted the sites’ U.S. counterparts. Prosper in November 2008 stopped all new lending after the U.S. Securities and Exchange Commission issued a cease-and-desist letter characterizing the website as a seller of investments, a label Prosper had resisted by arguing it was a marketplace matching lenders and borrowers.

Five months later, California regulators allowed the company to resume raising money in the state and lending it out under a system that lets borrowers and lenders use bids to set the interest rates on loans.

China’s policy makers are trying to regulate the excesses of private lending after a spate of suicides and bankruptcies around the country led to defaults, lawsuits and protests.

“Informal lending through various forms has been an integral part of China’s financial system because not all of its functions can be replaced by banks,” said He Wenguang, an economics professor at China Agricultural University in Beijing, whose research focuses on rural and microfinancing. “It will continue to exist with or without government interference.”

Beyond Lending

CreditEase, established as a peer-to-peer lending site in 2006, has now become a provider of wealth-management services, credit ratings and rural financing, drawing investment from venture-capital firm IDG Capital Partners and Morgan Stanley’s Asia fund. The company doesn’t have the licenses required by the banking and securities regulator for these services.

“We are a company that provides all types of services, including financial planning,” said Tang Ning, founder and CEO of CreditEase. “We don’t consider ourselves simply a lender.”

Tang, who went to Bangladesh to study microfinance under Yunus, said Beijing-based CreditEase is registered as a service company, not a lending organization.

Ppdai License

To ensure that it could continue to grow in the absence of clear regulation, Ppdai sought an operating license as a provider of “financial-information services,” Zhang said. After numerous visits by officials from the central bank and city government, Ppdai was granted the license in May by Shanghai’s Administration for Industry & Commerce, he said.

Providing financial information isn’t what peer-to-peer lending is about, raising more questions from users such as Qiu.

“I am still not sure whether my investment is legal or not,” said Qiu, whose loans included 500 yuan for a borrower’s apartment renovation and 400 yuan to a paint seller in Chongqing. “I can manage default risks by screening borrowers, but there is nothing I can do if the whole website turns out to be a scam. So finally, who’s the police on this place if that really happens?”

–Luo Jun. Editors: Sheridan Prasso, Robert Friedman

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